ProfessorBainbridge.com

SEC Commissioner Hester Pierce says corporate law is public interest law, which is true, but I said it first!

From her address to the Michigan Law School:

I want to urge you to expand your vision of how one can serve the public as a lawyer. Representing corporations also can be a form of public interest law because companies contribute so much to the well-being of society. I am not referring to corporate sponsorship of the local minor league baseball team, food bank, or youth orchestra. These charitable activities are laudable, but, to find something good, we need not look beyond the core profit-making activities of the corporation.

The hunt for profit drives companies to strive to identify and meet people’s needs using as few resources as possible. Companies communicate with their customers and suppliers through the price system. People tell companies what they value when they pay for the products and services those companies offer. Suppliers, by raising or lowering prices, tell companies how valuable the resources are that the companies use. Companies respond to what their customers and suppliers tell them. In this way, companies help to ensure that people spend their time wisely and that resources are used for the things society values most. Companies combine the diverse and complementary talents of their employees to research, develop, explore, produce, sell, and provide services to willing customers. In these activities, corporations play an important role in expanding scientific and technological knowledge, enabling people to profit from their hard work, and ensuring that society’s resources are allocated to the uses we most value.

As a lawyer representing companies in the courtroom, the boardroom, or the contract negotiating room, you are helping to build mutually beneficial relationships between companies and their creditors, shareholders, employees, suppliers, and communities. You are part of the process for ensuring that resources and human ingenuity are being put to their best use. It is easy to lose sight of the importance of your role particularly when you are an overtired attorney mired in a document-intense business dispute or interminable contract negotiation.

I couldn't agree more. Especially because I said the very same thing over a decade ago, in my article Reflections on Twenty Years of Law Teaching, 56 UCLA Law Review Discourse 1 (2008):

Legal education pervasively sends law students the message that corporate lawyering is a less moral and socially desirable career path than so-called “public interest” lawyering.[1]The corporate world is viewed as essentially corrupting and alienating, while true self-actualization is possible only in a Legal Aid office.

Our students get these messages not only in law school, of course, but also in the media. Films like “A Civil Action” or “Erin Brockovich” illustrate the general ill repute in which corporations—and corporate lawyers—are held, at least here in Hollywood.

In my teaching, I have chosen to unabashedly embrace a competing view. I tell my students about Nicholas Murray Butler, president of Columbia University and winner of the Nobel Peace Prize, who wrote that: “The limited liability corporation is the greatest single discovery of modern times. Even steam and electricity are less important than the limited liability company.”

I tell them about journalists John Micklethwait and Adrian Wooldridge, whose magnificent history, The Company, contends that the corporation is “the basis of the prosperity of the West and the best hope for the future of the rest of the world.”[2]

There is no doubt that the corporation is now the key economic institution in Western nations. In the United States, for example, the corporation is the predominant form of business organization by every measure except sheer number of firms. According to recent census data, although corporations account for only about one fifth of all business organizations, they bring in almost 90% of all business receipts.

The corporation also has proven to be a powerful engine for focusing the efforts of individuals to maintain economic liberty. Because tyranny is far more likely to come from the public sector than the private, those who for selfish reasons strive to maintain both a democratic capitalist society and, of particular relevance to the present argument, a substantial sphere of economic liberty therein serve the public interest.  Put another way, private property and freedom of contract were “indispensable if private business corporations were to come into existence.”[3]In turn, by providing centers of power separate from government, corporations give “liberty economic substance over and against the state.”[4]

Yet, two centuries ago, leading business and economic thinkers – including the great Adam Smith – derided the joint stock company. Few businesses were organized as chartered companies. Each company’s charter required a special legislative act. In many places, legislatures granted charters only to quasi-public entities, such as railroads and canals. In most, legislatures rarely resisted the temptation to revise or even repeal existing charters arbitrarily. Even in the United States, where the Supreme Court’s famous Dartmouth Collegedecision gave corporations substantial constitutional protections at a relatively early date, such legislative meddling remained commonplace.

And so I ask my students: What explains the relatively rapid development in the mid-19th century of a recognizably modern corporation and, in turn, that entity’s emergence as the dominant form of economic organization?

The answer has to do with new technologies – especially the railroad – requiring vast amounts of capital, the advantages such large firms derived from economies of scale, the emergence of limited liability that made it practicable to raise large sums from numerous passive investors, and the rise of professional management.

For the most part, these advantages remain true today. The corporation remains the engine of economic growth, both at the level of giants like Microsoft and garage-based start-ups.

The rise of the corporate form thus has “improved the living standards of millions of ordinary people, putting the luxuries of the rich within the reach of the man in the street.”[5]The rising prosperity made possible by the tremendous new wealth created by industrial corporations was a major factor in destroying arbitrary class distinctions, enhancing personal and social mobility. Many of the wealthiest businessmen of the latter half of the 19th Century and the 20th Century began their careers as laborers rather than as scions of coupon-clipping plutocrats.

And so I put it to my students this way: You want to help make society a better place? You want to eliminate poverty? Become a corporate lawyer. Help businesses grow, so that they can create jobs and provide goods and services that make people’s lives better.

The goal isn’t just to make my students feel better about themselves. I firmly believe that too many of our students, when they get out in practice, may be more willing to act in ways that are ethically gray—to act as facilitators rather than gatekeepers—if they’ve been told repeatedly that they’ve already “sold out.”[6]If more legal academics were to celebrate the pro-social aspects of corporate practice, perhaps our students would be better gatekeepers once they get out in practice.

California SB 826--The Board Gender Quota Bill--Should Be Unconstitutional Under the Commerce Clause

Professor Bainbridge: California Corporate-Board Quota Law Unlikely to Survive a Constitutional Challenge https://t.co/0NTY2uNty6

— Professor Bainbridge (@ProfBainbridge) October 2, 2018

What is a joint stock association?

The always interesting Keith Paul Bishop notes that:

California's statutory provisions pertaining to unincorporated associations can be found in Title 3 of the Corporations Code.  Part 3 of Title 3 is devoted to criminalizing various activities on the part of directors, officers and agents of joint stock associations.  Nowhere, however, Part 3 define what constitutes a joint stock association.  Nor does it appear that there are any decisions citing these statutes.  The mystery of what exactly constitutes a joint stock association is deepened by the existence of other provisions within the Corporations Code that refer to joint stock companies (e.g., §§ 5065, 25013, and 29514).  Is a "joint stock association" a "joint stock company" by another name or an entirely different entity? 

According to a 1916 law review article, a joint stock association at common law was "a group of individuals organized for certain purposes into an association similar to a partnership, but, unlike a partnership, having a capital stock divided into shares transferable by the owner".  I. Maurice Wormser, The Legal Status of Joint Stock Associations, 3 Fordham L. Rev. 1 (1916). 

This piqued my interest. Book 28 of the 1917 edition of McKinney's Consolidated Laws of New York Annotated covers "Joint Stock Association Law," section 2 of which states:

Christine Rossini's English as a Legal Language tells us that:

So far it looks like a "joint stock association" in act is a "joint stock company" by another name, but let us persevere:

The Georgia Nonprofit corporation statute (Ga. Code Ann. § 14-3-1108) supports that conclusion:

“Joint-stock association” includes any association of the kind commonly known as a joint-stock association or joint-stock company and any unincorporated association, trust, or enterprise having members or having outstanding shares of stock or other evidences of financial and beneficial interest therein, whether formed by agreement or under statutory authority or otherwise, but shall not include a corporation, partnership, limited liability partnership, limited liability company, or nonprofit organization. A joint-stock association as defined in this paragraph may be one formed under the laws of this state, including a trust created pursuant to Article 2 of Chapter 12 of Title 53, or one formed under or pursuant to the laws of any other state or jurisdiction.

DGCL § 254(a) is similar:

The term “joint-stock association” as used in this section, includes any association of the kind commonly known as a joint-stock association or joint-stock company and any unincorporated association, trust or enterprise having members or having outstanding shares of stock or other evidences of financial or beneficial interest therein, whether formed or organized by agreement or under statutory authority or otherwise and whether formed or organized under the laws of this State or any other jurisdiction, but does not include a corporation, partnership or limited liability company.

Yet, as a law review article explains, that definition presents its own set of problems:

Although the definition of a “joint-stock association” is quite broad and would seem to pick up almost all forms of non-corporate entities, there exists substantial ambiguity in the statute as to exactly what is a joint stock association given the exclusion of partnerships and corporations from the definition. For example, is a joint venture (which is nothing more than a partnership under another name) a joint-stock association under Delaware law? Similarly, would a joint venture be considered a joint-stock association if the agreement creating the joint venture provided that all the investors would receive shares and that the joint venture is not a partnership? 

Curtis W. Huff, Choice of State of Incorporation -- Texas Versus Delaware: Is It Now Time to Rethink Traditional Notions?, 31 Bull. Bus. L. Sec. St. B. Tex. 9, 37 (DEC 1994).

Make of it what you will.

I hate to break it to Josh Fershee but "Judgmenty" is not a word

Nonetheless I enjoyed his first and second posts on the corporate governance and corporate law aspects of Nike's controversial ad using Colin Kaepernick.

Ann Lipton revisits the corporate governance and corporate law aspects of les Moonves ouster at CBS

Here

Henderson and Bainbridge Podcast on Outsourcing the Board of Directors

Is the duty of loyalty really shrinking?

Interesting new article by Julian Velasco:

Fiduciary duties comprise an integral part of corporate law. It is generally understood that directors owe the corporation and its shareholders two fiduciary duties: the duty of care and the duty of loyalty. Although both duties are firmly established in corporate law, they are not treated equally. It is generally understood that the duty of loyalty is enforced far more rigorously than the duty of care. The justification for this dichotomy is twofold. First, differential treatment is appropriate because of the relative urgencies of the underlying subject matter: loyalty issues pose greater risks than do care issues. Second, the deference of the business judgment rule is made possible by the rigor of the entire fairness test: directors who are not conflicted can be trusted. In this Article, I demonstrate that the duty of loyalty is not enforced as rigorously as is commonly believed. Over fifty years ago, Professor Harold Marsh argued that the duty of loyalty had been watered down substantially over the preceding century. I argue that the diminishment of the duty of loyalty has continued and increased substantially since the time of his writing. I catalog various legal developments that have had the effect of curtailing the enforcement of the duty of loyalty significantly. As a result of these developments, I maintain that the corporate law reality does not currently match the corporate law theory. I argue that some sort of realignment is necessary: either the law must be amended to correspond to the theory, or the theory must be revised to reflect reality.

Velasco, Julian, The Diminishing Duty of Loyalty (August 27, 2018). 75 Wash. & Lee L. Rev. 1035 (2018). Available at SSRN: https://ssrn.com/abstract=3239605

To what extent should a board of directors be liable for not preventing a company's CEO from using racial slurs?

Bloomberg reports:

A Papa John's investor filed a putative class action against the pizza chain Aug. 30 for allegedly misleading shareholders about Schnatter's conduct, not having adequate systems in place to prevent inappropriate workplace conduct, and negatively affecting the company's business and reputation. Schnatter, who is also named as a defendant in the U.S. District Court for the Southern District of New York complaint, resigned from his position as chairman of the Papa John's board in July after reports that he'd used a racial slur on a conference call.

Schnatter's conduct hurt the company's bottom line, the investor complaint alleged. Pizza sales slowed after Schnatter's use of the slur became public, according to a Bloomberg report. The company's stock price also declined by 4.84 percent, the complaint said.

I found myself rolling my eyes as I read this silliness. It immediately called to mind Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 833 A.2d 961 (Del. Ch. 2003), aff'd, 845 A.2d 1040 (Del. 2004):

The market for MSO products is uniquely tied to the personal image and reputation of its founder, Stewart. MSO retains “an exclusive, worldwide, perpetual royalty-free license to use [Stewart's] name, likeness, image, voice and signature for its products and services.”7 In its initial public offering prospectus, MSO recognized that impairment of Stewart's services to the company, including the tarnishing of her public reputation, would have a material adverse effect on its business. ...

Stewart was accused of insider trading in Imclone stock:

Ultimately Stewart's prompt efforts to turn away unwanted media and investigative attention failed. Stewart eventually had to discontinue her regular guest appearances on CBS' The Early Show because of questioning during the show about her sale of ImClone shares. After barely two months of such adverse publicity, MSO's stock price had declined by slightly more than 65%. In August 2002, James Follo, MSO's chief financial officer, cited uncertainty stemming from the investigation of Stewart in response to questions about earnings prospects in the future.

Plaintiff sued claimed that "the director defendants and defendant *971 Patrick breached their fiduciary duties by failing to ensure that Stewart would not conduct her personal, financial, and legal affairs in a manner that would harm the Company, its intellectual property, or its business." The court tossed the claim:

Even if I accept that the board knew that Stewart's personal actions could result in harm to MSO, it seems patently unreasonable to expect the Board, as an exercise of its supervision of the Company, to preemptively thwart a personal call from Stewart to her stockbroker or to fully control her handling of the media attention that followed as a result of her personal actions, especially where her statements touched on matters that could subject Stewart to criminal charges. Plaintiff has not cited any case to support this new “duty” to monitor personal affairs. Since the defendant directors had no duty to monitor Stewart's personal actions, plaintiff's allegation that the directors breached their duty of loyalty by failing to monitor Stewart because they were “beholden” to her is irrelevant. Count II is dismissed for failure to state a claim.

The court further explained that:

Regardless of Stewart’s importance to MSO, she is not the corporation. And it is unreasonable to impose a duty upon the Board to monitor Stewart’s personal affairs because such a requirement is neither legitimate nor feasible. Monitoring Stewart by, for example, hiring a private detective to monitor her behavior is more likely to generate liability to Stewart under some tort theory than to protect the Company from a decline in its stock price as a result of harm to Stewart’s public image.

So the claim that Papa John's board "is liable not having adequate systems in place to prevent inappropriate workplace conduct" should be a non-starter.

Keith Paul Bishop on the De Facto Merger Doctrine in California

Keith Paul Bishop responds to my post about the status of the de facto merger doctrine under California law, in which I tagged him:

As an initial matter, it must be understood that there are at least two applications of the de facto merger doctrine.  The first, as described above, imposes a selling corporation's debts and liabilities on a successor corporation in an asset sale transaction.  The second involves whether shareholders of the selling corporation will enjoy voting and dissenters rights in an asset sale transaction.  In Jones v. H.F. Ahmanson & Co., 1 Cal. 3d 93, 117 (1969), Justice Roger Traynor noted that "Judicial protection has also been afforded the shareholder who is the victim of a "de-facto merger" to which he objects" (citing Farris v. Glen Alden Corp. 123 A.2d 25 (1958)).  

The Ahmanson case predates the current General Corporation Law which largely moots the discussion by defining a "reorganization" to include a sale-of-assets reorganization.  Cal. Corp. Code § 181(c).  See also When a Sale of Assets is not a "Sale-of-Assets Reorganization".  

Thanks!

Francis Pileggi on Brett Kavanaugh on Delaware Corporate Law

Here

Does California Recognize the De Facto Merger Doctrine Outside the Successor Liability Context?

I awoke this morning to find I had been tagged in the following tweet:</p?

Nice potential example for corporations casebook, if it gets to an opinion. (cc: @ProfBainbridge) https://t.co/kdtAnEPpOW

— Dave Hoffman (@HoffProf) September 13, 2018

It is true that California recognizes the de facto merger doctrine in successor liability cases. In Marks v. Minnesota Mining & Mfg. Co., 232 Cal. Rptr. 594 (Cal. App. 1st Dist. 1986), for example, "plaintiff filed a complaint for strict products liability, breach of warranty, and negligence against Minnesota Mining and Manufacturing Co. (3M) and McGhan Medical Corporation. 3M and McGhan Medical Corporation" alleging that they had manufactured a defective "inflatable mammary prosthesis used in breast augmentation surgery." The prosthesis had been manufactured by McGhan. Subsequently thereto McGhan's assets were sold to 3M, but 3M did not acquire McGhan's liabilities. 

In general, in such cases the liabilities remain with the seller and the purchaser takes the assets free of any attached liabilities. 

As the Third Circuit has explained:

Under the well-settled rule of corporate law, where one company sells or transfers all of its assets to another, the second entity does not become liable for the debts and liabilities, including torts, of the transferor.

Four generally recognized exceptions qualify this principle of successor nonliability. The purchaser may be liable where: (1) it assumes liability; (2) the transaction amounts to a consolidation or merger; (3) the transaction is fraudulent and intended to provide an escape from liability; or (4) the purchasing corporation is a mere continuation of the selling company.

The successor rule was designed for the corporate contractual world where it functions well. It protects creditors and dissenting shareholders, and facilitates determination of tax responsibilities, while promoting free alienability of business assets. The doctrine reflects the general policy that liabilities adhere to and follow the corporate entity. However, when the form of the transfer does not accurately portray substance, the courts will not refrain from deciding that the new organization is simply the older one in another guise.[1]

As noted, California does recognize the de facto merger doctrine in successor liability cases arising from tort. But the case to which Professor Hoffman drew my attention is not a traditional tort case involving successor liability:

Sixteen former Dickstein Shapiro partners have sued Blank Rome claiming the 2016 merger between the two firms was inappropriately styled as a sale to avoid paying out more than $4 million in capital accounts owed to former partners.

“Blank Rome’s transactional attorneys tried to ‘play cute’ by structuring the merger of Dickstein Shapiro into its law firm by the artifice of labeling it as an ‘asset sale’ for the solitary purpose of defrauding former Dickstein Shapiro partners (who were necessarily not going to be a part of Blank Rome),” wrote the former Dickstein Shapiro’s lawyers at Kabateck Brown Kellner and The Kellner Law Group in Los Angeles in a complaint filed Wednesday in Los Angeles Superior Court.

“This lawsuit has no merit and we intend to vigorously defend it,” a Blank Rome spokeswoman said in email Thursday morning.

The lawsuit, filed on behalf of 15 partners who left Dickstein in the run-up to the Blank Rome deal and one who retired about a month prior to the February 2016 tie-up, seeks a declaratory judgement that the deal was a “de facto merger.” Such a finding, the former partners claim, would leave Blank Rome liable for Dickstein’s debts and in breach of the defunct firm’s partnership agreement with former partners, which required the firm to pay back departing partners’ capital accounts with interest.

Instead, this case arguably is more analogous to cases in which shareholders seek to use the de facto merger doctrine so as to obtain voting or appraisal rights in a transaction designed to deprive them of those rights.

Assume that Buyer Corporation and Target Inc. agree that Buyer will acquire Target via a reverse triangular merger. As a result, Buyer's shareholders will not be entitled to vote on the merger nor will they be eligible for appraisal rights. Disgruntled Buyer shareholders sue, arguing that the reverse triangular merger is a de facto merger. If the court agrees, the court will ignore the form of the transaction, treat the deal as a standard two‑party merger, and grant both Buyer and Target shareholders the right to vote and the right to dissent.

Why did the Delaware courts and the Pennsylvania legislature reject the de facto merger doctrine? Is it simply that they prefer corporate interests to shareholder interests? No. The statute provides various ways of accomplishing an acquisition. It does so because no one acquisition technique is always appropriate. If we let courts recharacterize the statutory alternatives, we increase uncertainty and we eliminate the wealth‑creating advantages of having multiple acquisition formats.

Assuming the court decides that this case is more akin to de facto merger cases brought by shareholders than those brought by tort claimants in products liability cases, the pertinent question is whether California recognizes de facto merger outside the successor liability context.

A quick Westlaw search this morning seemed to kick up only successor liability cases. So I’m going to tag in Keith Paul Bishop.

 

[1]Polius v. Clark Equipment Co., 802 F.2d 75, 77-78 (3d Cir 1986) (citations omitted).

A short essay on corporate philanthropy

A.P. Smith Manufacturing Co. v. Barlow, the most frequently cited example of cases validating corporate social responsibility, upheld a corporate charitable donation on the ground, inter alia, that “modern conditions require that corporations acknowledge and discharge social as well as private responsibilities as members of the communities within which they operate.”[1]Ultimately, however, the differences between Barlowand cases like Dodgev. Ford Motor Co.[2]have little more than symbolic import. As the Barlowcourt recognized, shareholders’ long-run interests are often served by decisions (such as charitable giving) that appear harmful in the short-run. Because the court acknowledged that the challenged contribution thus could be justified on profit-maximizing grounds, its broader language on corporate social responsibility is arguably mere dictum.

As we have seen, A. P. Smith Manufacturing Co. v. Barlow,[3]is often cited as a leading corporate social responsibility decision. Ironically, however, the specific question presented therein—the validity of corporate philanthropy—has been resolved in a more narrow way. Corporate charitable donations are subject to attack under two doctrines: ultra vires and breach of fiduciary duty. Neither is likely to succeed, so long as the amount in question is reasonable and some plausible corporate purpose may be asserted.

Virtually all states have adopted statutes specifically granting corporations the power to make charitable donations,[4]which eliminates the ultra vires issue. Although these statutes typically contain no express limit on the size of permissible gifts, courts interpreting the statutes require corporate charitable donations to be reasonable both as to the amount and the purpose for which they are given.[5]The federal corporate income tax code’s limits on the deductibility of corporate charitable giving are often used by analogy by courts seeking guidance on whether a gift was reasonable in amount.

As for breach of fiduciary duty claims, the principles announced in Dodge v. Ford Motor Co.[6]arguably require that corporate philanthropy redound to the corporation’s benefit. As Shlensky v. Wrigley[7]suggests, however, reasonable corporate donations should be protected by the business judgment rule.[8]Consequently, Barlow’s discourse on corporate social responsibility properly is regarded as mere dicta.

Can California Require Delaware Corporations to Comply with California's New Board of Director Gender Diversity Mandate? No.

Kim Krawiec reports:

Thanks to California, corporate board diversity or, more specifically, gender diversity, is in the news again. SB 826 which, according to news reports, Gov. Jerry Brown is expected to sign, passed the state Senate in a 23-9 vote and the Assembly in a 41-26 vote. The statute would require “publicly held domestic or foreign corporation[s] whose principal executive offices, according to the corporation’s SEC 10-K form, are located in California” to have a minimum of one female director on its board by the end of 2019. By the end of 2021, those numbers would increase for corporations with five directors, who would need to have a minimum of two female board members, and for corporations with six or more directors, who would need to have at least three female board members.

Kim goes on to review the policy arguments pro and con. Kevin Paul Bishop has a somewhat more detailed description of the bill.

In this post, I consider whether California can do this as a constitutional matter. 

Opponents of the legislation are mainly focusing on equal protection arguments, claiming that neither the U.S. nor the California constitutions prohibit the sort of quotas contemplated by the bill. I think there’s another issue raised by the statute, however.

Virtually all U.S. corporations are formed (“incorporated”) under the laws of a single state by filing articles of incorporation with the appropriate state official.[1]The state in which the articles of incorporation are filed is known as the “state of incorporation.” Selecting a state of incorporation has important consequences, because of the so-called “internal affairs doctrine”—a conflicts of law rule holding that corporate governance matters are controlled by the law of the state of incorporation.

Suppose, for example, that Acme, Inc., is incorporated in Delaware, but all of Acme’s assets are located in Illinois. All of Acme’s shareholders, directors, and employees reside in Illinois. Acme’s sole place of business is located in Illinois. An Acme shareholder brings suit against the board of directors, alleging that its members violated their fiduciary duty of care. The law suit is filed in an Illinois court. Despite all these Illinois ties, the Illinois court usually nevertheless will apply Delaware law.[2]

The internal affairs doctrine developed on the premise that, in order to prevent corporations from being subjected to inconsistent legal standards, the authority to regulate a corporation's internal affairs should not rest with multiple jurisdictions. … By providing certainty and predictability, the internal affairs doctrine protects the justified expectations of the parties with interests in the corporation.[3]

The internal affairs doctrine takes on particular transactional significance when considered in conjunction with the constitutional restrictions on a state’s ability to exclude foreign corporations. With rare exceptions, states have always allowed foreign and pseudo-foreign corporations to do business within their borders. As early as 1839, for example, the U.S. Supreme Court held that federal courts should presume a state would recognize foreign corporations in the absence of an express statement to the contrary by the legislature.[4]A subsequent Supreme Court decision implied that states could not exclude foreign corporations from doing business within the state provided that the business constituted interstate commerce under the Commerce Clause of the U.S. Constitution.[5]These decisions effectively created a common market for corporate charters. If Illinois, for example, adopts a restrictive corporation law, its businesses are free to incorporate in a less restrictive state, such as Delaware, while continuing to conduct business within Illinois.

Virtually all U.S. jurisdictions follow the internal affairs doctrine, even if the corporation in question has virtually no ties to the state of incorporation other than the mere fact of incorporation. A few states make a more general exception to the internal affairs doctrine for so-called pseudo-foreign corporations. A foreign corporation is one incorporated either by a state or nation other than the state in question. A pseudo-foreign corporation that has most of its ties to the state in question rather than to the state of incorporation. Many Delaware corporations are pseudo-foreign corporations. They are incorporated in Delaware, but most of their operations are located in one or more other states. In most states, there is no significant legal difference between a foreign and a pseudo-foreign corporation, and the internal affairs doctrine will be applied to invoke the law of the state of the incorporation with respect to both. California and New York are the principal exceptions to this rule. Both states purport to apply parts of their corporate laws to pseudo-foreign corporations formed in other states but having substantial contacts with California or New York.[6]SB 826 is the latest salvo in this struggle.

In 2005, the Delaware supreme court held that the general California statute was unconstitutional under the Due Process and Commerce Clauses of the U.S. Constitution.[7]

The internal affairs doctrine is not, however, only a conflicts of law principle. Pursuant to the Fourteenth Amendment Due Process Clause, directors and officers of corporations “have a significant right ... to know what law will be applied to their actions” and “[s]tockholders ... have a right to know by what standards of accountability they may hold those managing the corporation's business and affairs.” Under the Commerce Clause, a state “has no interest in regulating the internal affairs of foreign corporations.” Therefore, this Court has held that an “application of the internal affairs doctrine is mandated by constitutional principles, except in the ‘rarest situations,’ ” e.g., when “the law of the state of incorporation is inconsistent with a national policy on foreign or interstate commerce.”[8]

Ultimately, of course, the U.S. Supreme Court will have to decide the issue.

In my view, however, the Sureme Court will come down on Delaware’s side.

… application of local internal affairs law (here California's section 2115) to a foreign corporation (here Delaware) is “apt to produce inequalities, intolerable confusion, and uncertainty, and intrude into the domain of other states that have a superior claim to regulate the same subject matter....” Professor DeMott's review of the differences and conflicts between the Delaware and California corporate statutes with regard to internal affairs, illustrates why it is imperative that only the law of the state of incorporation regulate the relationships among a corporation and its officers, directors, and shareholders. To require a factual determination to decide which of two conflicting state laws governs the internal affairs of a corporation at any point in time, completely contravenes the importance of stability within inter-corporate relationships that the United States Supreme Court recognized in CTS.[9]

Unlike 2115, SB 826 tries to finesse that holding by limiting its application to quasi-foreign corporations “whose principal executive offices, according to the corporation’s SEC 10-K form.” I doubt whether that is sufficient, however. Let’s start with general principles. The Court has emphasized that “state regulation of corporate governance is regulation of entities whose very existence and attributes are a product of state law,”[10]from which the Court extrapolated the proposition that “it . . . is an accepted part of the business landscape in this country for States to create corporations, to prescribe their powers, and to define the rights that are acquired by purchasing their shares.” In keeping with that principle, the Court emphasized that state law governs the rights and duties of corporate directors: “As we have said in the past, the first place one must look to determine the powers of corporate directors is in the relevant State’s corporation law. . . . ‘Corporations are creatures of state law’ . . . and it is state law which is the font of corporate directors’ powers.”[11]Granted, none of these cases are directly on point, but taken together they suggest the Court will recognize the constitutional status of the internal affairs doctrine.

Now let’s drill down a bit. As Jack Jacobs (former Delaware Vice Chancellor and Supreme Court Justice) has noted, a problem with the California and New York statutes is that they “have extraterritorial reach because they legislatively overrule the internal affairs doctrine and impose their own, often different, internal governance requirements upon foreign corporations having a specified level of contact with the forum state.”[12]In Edgar v. Mite, a plurality of the Supreme Court held said that an Illinois statute violated the commerce clause of the U.S. Constitution because, inter alia, of the statute’s “sweeping extraterritorial effect.”[13]“The limits on a State's power to enact substantive legislation are similar to the limits on the jurisdiction of state courts. In either case, ‘any attempt “directly” to assert extraterritorial jurisdiction over persons or property would offend sister States and exceed the inherent limits of the State's power.’”[14]

SB 826 has similar extraterritorial effect. Imagine a Delaware corporation with operations in many countries around the world, as well as numerous U.S. states. While its principal executive offices are located in California, only about 3% of the company’s operations are located in California. A sizeable majority of the company’s board of directors are domiciles of other states (and even other countries). The board routinely holds conference calls linking directors at locations around the globe. The board’s regular meetings take place in various locations throughout the United States.

Suing the Vatican: The St. Bernard Case

The sex abuse charges now roiling the Catholic Church are a serious matter. But this tweet reminded me of one of my favorite cases, which is not very serious:

“The only valid reason for using RICO against the Vatican or any entity of the Catholic church, in the context of child sexual abuse, is to gain publicity or access to more clients,” said Notre Dame law prof G. Robert Blakey, the nation’s foremost expert on racketeering law. 2002

— Joanna Nuval (@janeway529) August 28, 2018

In 1968, William Sheffield visited the ancient Hospice du Grand St. Bernard in Switzerland, a monastery of the Canons Regular of St. Augustine, a Roman Catholic religious order of priests. While in Switzerland, Sheffield contracted with the cleric in charge, Father Bernard Cretton, to buy a St. Bernard dog for $175 plus the $125 freight to ship the dog to Sheffield’s home in California. Sheffield was to pay the price in $20 installments and Cretton agreed to ship the dog upon receipt of the first $20.[1]

Sheffield made three $20 payments, but the monastery refused either to ship a dog or to refund his money. Sheffield then sued in California state court for the price of his substitute dog ($200) and his non-refunded $60. In the suit, he named Cretton, the Canons Regular, the Vatican, the Pope, and the local archdiocese (in the person of then-presiding Archbishop of San Francisco).[2]

Although Sheffield apparently was able to serve process on and obtain personal jurisdiction with respect to the Archbishop of San Francisco, he faced significant obstacles in doing so with respect to both the Pope and the monastic defendants. In an attempt to circumvent those problems, Sheffield invoked the alter ego doctrine:

The complaint alleges that defendants Archbishop and the Canons Regular of St. Augustine were controlled and dominated by defendants Roman Catholic Church, the Bishop of Rome and the Holy See, that there exists a “unity of interest and ownership between all and each of the defendants,” that the Archbishop and the Canons Regular were a “mere shell and naked framework which defendants Roman Catholic Church, The Bishop of Rome, and The Holy See, have used and do now use as a mere conduit for the conduit of their ideas, business, property, and affairs,” and that all defendants are “alter egos” of each other.[3]

The court rejected Sheffield’s argument, holding that the “uncontroverted” evidence that “the Archbishop had no dealings with the Canons Regular negates any possibility that the Archbishop so controlled and dominated that organization so as to be liable for its actions under the ‘alter ego’ doctrine.”[4]

I've Posted a New Article to SSRN: Corporate Purpose in a Populist Era

I've posted a new article to SSRN: 

Corporate Purpose in a Populist Era (August 22, 2018). UCLA School of Law, Law-Econ Research Paper No. 18-09. Available at SSRN: https://ssrn.com/abstract=3237107

Abstract:

In the wake of the 2016 US Presidential election and similar developments in parts of Europe, commentators widely acknowledged the rise of populist movements on both the right and left of the political spectrum that both were deeply suspicious of big business. This development potentially has important implications for the law and practice of corporate purpose.

Left of center corporate social responsibility campaigners have long advocated the use of “boycotts, shareholder activism, negative publicity, and so on” to pressure corporate managers to act in ways those campaigners deem socially responsible. Right of center populists could use the same tactics to induce corporate directors to make decisions they favor. The question thus is whether they are likely to do so based on their historical track record.

Assuming for the sake of argument that right-of-center populists begin focusing on corporate purpose, the question arises whether modifying the shareholder wealth maximization norms so as to give managers more discretion to take the social effects of their decisions into account would lead to outcomes populists would view as desirable. Populists historically have viewed corporate directors and managers as elites opposed to the best interests of the people. Today, right of center populists find themselves increasingly at odds with an emergent class of social justice warrior CEOs, whose views on a variety of critical issues are increasingly closer to those of blue state elites than those of red state populists.

Finally, this article reverses field by suggesting that the case for Delaware’s rule of shareholder wealth maximization becomes even stronger when right-wing populists have significant political power. A resurgent right-wing populism may provide alternative constraints on corporate political power sufficient to revitalize the argument for leaving regulation of corporate externalities to general welfare legislation.

Keywords: populism, corporate purpose, corporate social responsibility